Tax experts suggest ways to close $300 billion gap

WASHINGTON - Getting people to pay the taxes they owe could be one significant way of coping with dizzying increases in the federal deficit and the potential $700 billion price tag for the just-enacted financial rescue plan, tax experts said Thursday.

In 2001, the last year the Internal Revenue Service estimated the tax gap — the difference between what taxpayers owe and what they actually pay — the figure stood at $345 billion, or $290 billion after subtracting enforcement efforts and late payments. The overall compliance rate for paying taxes was about 86 percent.

The tax exports, at a forum hosted by Sen. Tom Carper, D-Del., said that in spite of some IRS successes in improving tax compliance, the gap may have grown since 2001.

"We believe $345 billion is a low-ball estimate," said J. Russell George, Treasury Inspector General for Tax Administration. "We believe it is much greater than that."

By comparison, the federal deficit for the just-ended budget year was a record $438 billion.

Carper said he had told Democratic presidential nominee Sen. Barack Obama, D-Ill., that reducing the tax gap was "a good place to go" when considering how to pay for the financial rescue package. "There's some low-hanging fruit here," said Carper, who chairs the Senate subcommittee on federal financial management.

The IRS, in a 2006 study on the gap, concluded that $197 billion came from underreporting on individual income tax returns while $88 billion was from underreporting by corporations and the self-employed. The remainder came from those not filing.

George said more third-party reporting would boost revenues coming into the IRS. He said people subject to withholding from their employers report 99 percent of their income, while the self-employed report only about 68 percent of income. That figure drops to 19 percent for those self-employed paid on a cash basis.

Small businesses should be encouraged to participate in an electronic federal tax payment system which allows for scheduled, automatic payments, National Taxpayer Advocate Nina Olson said. The IRS has to make the program more user-friendly, she said. "We have to make it easier for taxpayers to pay their government."

Among other suggestions:

• Withhold payments to federal contractors who don't pay their taxes. A recent Government Accountability Office report estimated that government contractors owe more than $6 billion in taxes.
   
• Require that financial institutions report information about non-interest-bearing accounts. Taxpayers have avoided paying taxes by putting their money in non-interest checking accounts.
   
• Match federal and state tax data. A 2007 IRS study in Iowa found 2,607 instances where the sales reported to the state revenue agency exceeded the sales reported to the IRS by $100,000 or more.
   
• Clarify laws allowing restaurants and waiters to enter into agreements to pay taxes on an estimated percentage of tips.
   
• Eliminate the law under which businesses need not report payments to closely held corporations.
   
• Better regulate paid tax preparers. Government Accountability Office officials told Carper there appeared to be widespread underreporting and mistakes in returns filed by tax preparers.